Greek ruin starts earthquake

The fear that began in Athens, raced through Europe and finally shook the sharemarket in the US is affecting the broader global economy. It is now making waves all the way from the ability of Asian corporations to raise money to the outlook for money-market funds where American savers park their cash.

What was once a local worry about the debt burden of one of Europe’s smallest economies has gone global. Jittery investors have forced Brazil to scale back bond sales as interest rates soared and caused currencies in Asia such as the Korean won to weaken. Ten global companies that had planned to issue stock delayed their offerings, the most in a single week since October 2008.

The anxiety threatened to slow the US recovery and inhibit consumer spending as stock portfolios shrink and loans are harder to come by.

“It’s not just a European problem, it’s the US, Japan and the UK," said Ian Kelson, a bond fund manager in London with T Rowe Price.

“It’s across the board."

The crisis was so perilous for Europe that the leaders of the 16 countries that use the euro currency worked into the early morning on Saturday on a proposal to create a so-called stabilisation mechanism intended to reassure the markets. On Sunday, all European Union finance ministers were expected to gather in Brussels to discuss and possibly approve the proposal.

The mechanism would probably be a way for the countries, and possibly the European Central Bank, to guarantee loans taken out by the European Commission, the bloc’s executive body, to support ailing economies. European leaders including French President
Nicolas Sarkozy
said the EU should be ready to activate the mechanism by Monday morning if needed.

In Spain on Saturday, US Vice-President
Joe Biden
underscored the issue’s importance after a meeting with President José Luis Rodríguez
Zapatero
.

Related Quotes

Company Profile

“The President and I also spent time discussing the economic crisis that is focused on Greece and the efforts being made to address it," Mr Biden said. “We agreed on the importance of a resolute European action to strengthen the European economy and to build confidence in the markets. And I conveyed the support of the USA towards those efforts and was pleased to hear the efforts that were under way on the part of the president."

The debt crisis has sent waves of fear through global stock exchanges. A decade ago, it took more than a year for the chain reaction that began with the devaluation of the Thai currency to spread beyond Asia to Russia. It defaulted on its debt, and eventually caused the near-collapse of a giant American hedge fund, Long-Term Capital Management.

This crisis, by contrast, seemed to ricochet from country to country in seconds, as traders simultaneously abandoned everything from Portuguese bonds to American blue chips. Last week on Wall Street, televised images of rioting in Athens against austerity measures only amplified the anxiety as the sharemarket briefly plunged almost 1000 points.

William Gross, managing director of giant bond-management company Pimco Group, said: “Up until last week, there was this confidence that nothing could upset the apple cart as long as the economy and jobs growth was positive. Now, fear is back in play."

The immediate causes for concern were Greece’s ballooning budget deficit and the risk that other fragile countries such as Spain and Portugal might default. But the turmoil also exposed deeper fears that government borrowing in bigger nations such as Britain, Germany and even the US was unsustainable.

“Greece may just be an early warning signal," said Byron Wien, a prominent Wall Street strategist and vice-chairman of Blackstone Advisory Partners. “The US is a long way from being where Greece is, but the developed world has been living beyond its means and is now being called to account."

If the anxiety spreads, American banks could return to the posture they adopted after the collapse of Lehman Brothers in 2008. Then, they cut back sharply on mortgages, car financing, credit card lending and small business loans. That could stymie job growth and halt the nascent broader economic recovery.

Some American companies face higher costs to finance their debt, while big exporters are seeing their edge over European competitors shrink as the dollar strengthens. Riskier assets such as stocks are suddenly out of favour, while cash has streamed into the safest of all investments, gold.

Just as Greece is being forced to pay more to borrow, more risky American companies are being forced to pay up, too. Some issuers of new junk bonds in the consumer sector are likely to have to pay roughly 9 per cent on new bonds, up from about 8.5 per cent before this week’s volatility, said Kevin Cassidy, senior credit officer with Moody’s.

Not all of the consequences are negative, however. Though the situation is perilous for Europe, the US economy still has some favourable tailwinds. With the flight to quality prompted by this week’s market volatility, interest rates have dropped, benefiting home buyers seeking mortgages, and other borrowers. Data released on Friday showed the economy added 290,000 jobs in April, the best monthly showing in four years.

Further, crude prices fell last week on fears of a slowdown, which should bring lower prices at the pump within weeks. Meanwhile, the US dollar gained ground against the euro, reaching its highest level in 14 months.

While that makes European vacations more affordable for American tourists and could improve the fortunes of European companies, it could hurt profits at their American rivals. A stronger dollar makes American goods less affordable for buyers overseas, a one-two punch for American exporters if Europe falls into recession as a result of the crisis. Excluding oil, euro-zone countries buy about 14 per cent of American exports.

For the largest American companies, which have benefited from the weak dollar in recent years, the pain could be more acute. More than a quarter of the profits of companies in the Standard & Poor’s 500-stock index come from abroad, with Europe forming the largest component, said Tobias Levkovich, Citigroup’s chief US equity strategist.

All this could mean the difference between an economy that grows fast enough to bring down unemployment, and one that is more stagnant.

If Europe does end up in a double-dip recession, that could reduce US economic growth by 0.3 to 0.4 percentage points, said Bernard Baumohl, chief global economist for the Economic Outlook Group at Princeton.

The direct exposure of US banks to Greece is small, but below the surface, there are signs of other fissures. Even the strongest banks in Germany and France have heavy exposure to more troubled economies on the periphery of the continent. These big banks in turn are closely intertwined with their US counterparts. US banks have $US3.6 trillion in exposure to European banks, says the Bank for International Settlements. That includes more than $US1 trillion in loans to France and Germany, and nearly $US200 billion to Spain.

Money-market investors in the US are already feeling nervous about hundreds of billions of dollars in short-term loans to big European banks and other financial institutions. “Apparently systemic risk is alive and well," wrote Alex Roever, a JPMorgan credit analyst in a research note. With so much uncertainty about Europe and the euro, managers of the ultra-safe investment vehicles have demanded Europeans pay higher rates.

Now, as Europe teeters, the dangers to the US economy – and the broader financial system – are becoming increasingly evident. “It seems like only yesterday that European policymakers were gleefully watching the US get its economic comeuppance, not appreciating the massive tidal wave coming at them across the Atlantic," said Kenneth Rogoff, a Harvard professor of international finance who also served as the chief economist of the International Monetary Fund. “We should not make the same mistake."

The funds provide the lifeblood of the international banking system. If worries about the safety of European banks intensify, it could push up their borrowing costs and push down the value of more than $US500 billion in short-term debt held by US money-market funds. Uncertainty about the stability of assets in money market funds signalled a tipping point that helped accelerate the credit crisis in 2008, and ultimately prompted banks to briefly halt lending to each other.